Order inflow, debt concerns remain

Suzlon Energy’s return to profits is positive, but a weak order inflow and high debt are likely to weigh on its stock.

In spite of having reported a sharp turnaround in the March quarter, which came after losses in the previous seven, Suzlon Energy’s stock has remained flat. That’s because the profits were lower than most analysts’ expectations and more importantly, concerns persist in the form of high debt, rising interest rates, higher raw material prices and the absence of any meaningful demand in developed markets, which accounts for a majority of Suzlon’s consolidated sales.

Going ahead, the management expects the company to report consolidated revenues of Rs 24,000-26,000 crore in 2011-12, which is 34-45 per cent higher than Rs 18,090 crore in FY11, and earnings before interest and tax (EBIT) margins of 7-8 per cent. Although competition has increased in the business, these targets looks achievable given Suzlon’s strengths, track record, order book, cost-cutting initiatives, reduction in debt and working capital, integration of REpower and better utilisation.
 

RISING SALES, MARGINS
	FY10	FY11	FY12E	FY13E
Order book (Mw)	2,882	4,639	NA	NA
Order book (Rs)	18,472	30,253	NA	NA
Suzlon volumes (mw)	2,837	2,829	3,831	4,769
Revenue	20,779	18,090	23,523	30,102
Ebitda (%)	4.50	4.30	10.40	10.40
Ebit/Sales	1.00	1.00	8.00	8.00
Interest cost	1,195	1,136	1,226	1,378
Net profit	-983	-1,103	521	912
EPS (Rs)	-7.70	-5.80	2.90	5.10
PE (x)	NA	NA	17.60	10.00
Net debt to equity	1.30	1.40	1.30	1.20
BV (X)	42.40	37.90	40.80	45.40
E: Estimates. Figures in Rs cr unless otherwise indicated                                                                Source: BofA Merrill Lynch Global Research

At Rs 51.50, the stock trades at 18 times FY12 and 10 times FY13 earning estimates. Unless operational turnaround is sustained, debt levels come down and order inflows improve, it may not move up in a hurry.

VISIBILITY ISSUES
While the company reported a net profit of Rs 430 crore, it was boosted by forex gains. However, adjusting for the same, the profit figure of Rs 220 crore is still healthy (as against a loss of Rs 178 crore in the year-ago quarter) and comes on a 20 per cent growth in revenue and sharp improvement in operating margins. The benefits of cost cutting along with a 20 per cent improvement in consolidated realisation to Rs 5.34 crore per Mw help boost profitability. Reduction in working capital and net debt kept interest costs under control, which grew by less than 5 per cent.

Analysts though were disappointed that about 160 Mw of its domestic supplies got postponed (will reflect in coming quarters) due to which the company booked fewer sales during the quarter. However, the bigger worry is overall order inflows in the quarter were lower by 40 per cent. While order inflows from international markets dried up, REpower (Suzlon’s 95 per cent subsidiary), too, reported a 34.2 per cent year-on-year fall in order inflows. Unless this trend changes for the better, concerns over revenue visibility for the coming years will crop up.

TURNAROUND IN SIGHT
Meanwhile, Suzlon group closed the last financial year with an order book of 4,639 Mw, which is 61 per cent higher on a year-on-year basis, and should help achieve the revenue guidance for 2011-12. Strong growth in revenues should result in a sharper jump in profits, as it places the company in a better position to absorb fixed costs.

For instance, in 2010-11, the group generated sales volumes of 2,829 Mw and Ebit of Rs 257.33 crore (a mere 1.42 per cent in Ebit margin), which was not enough to cover the interest cost of Rs 1,136 crore leading to a net loss. This should change as even assuming sales of 4,000 Mw in 2011-12 (against the guidance of over 4,500 Mw), Suzlon could generate an EBIT of about Rs 2,000 crore, enough to cover the interest cost, leaving Rs 500-600 crore at the net level.

On a standalone basis, Suzlon’s break-even capacity utilisation level is about 1,900 Mw (it sold 1,521 Mw in 2010-11). If, as guided, the company is able to achieve sales of 2,500 Mw in 2011-12, it will contribute significantly to the margins. Also, it is taking initiatives to outsource a part of REpower’s production to India, which should further boost operating margins.

DEBT DOWN, BUT HIGH
Apart from operational gains, Suzlon has been working towards reducing its leverage as well, which though is far from the desired levels. Although Suzlon repaid over Rs 600 crore of debt in the last one year, its net debt still remains high at Rs 9,142 crore as on March 31, 2011. A large part of the outstanding loan, however, is working capital, which is expected to reduce further. The company's net consolidated working capital has fallen from Rs 4,872 crore in 2009-10 to Rs 3,788 crore in 2010-11. The company is striving to bring this down further through better management of receivables and inventories in addition to realising about Rs 1,000 crore from one of its old customers.

That apart, Suzlon will also get access to funds worth Rs 1,730 crore in REpower’s books, once it completes the process of buying out REpower’s minority shareholders (expected soon). Analysts believe that REpower’s cash can be used to partially fund FCCB redemption in 2012-13.

Put together, better operational cash flow, REpower’s funds and reduction in working capital should provide Suzlon with funds worth Rs 3,500-4,000 crore, which it can use to lower the debt further and ease concerns on this front.